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Author Archives: Chris Versace, Chief Investment Officer

About Chris Versace, Chief Investment Officer

I'm the Chief Investment Officer of Tematica Research and editor of Tematica Investing newsletter. All of that capitalizes on my near 20 years in the investment industry, nearly all of it breaking down industries and recommending stocks. In that time, I've been ranked an All Star Analyst by Zacks Investment Research and my efforts in analyzing industries, companies and equities have been recognized by both Institutional Investor and Thomson Reuters’ StarMine Monitor. In my travels, I've covered cyclicals, tech and more, which gives me a different vantage point, one that uses not only an ecosystem or food chain perspective, but one that also examines demographics, economics, psychographics and more when formulating my investment views. The question I most often get is "Are you related to…."
Weekly Issue: While Most Eyes Are on the Fed, We Look at a Farfetch(ed) Idea

Weekly Issue: While Most Eyes Are on the Fed, We Look at a Farfetch(ed) Idea

Key points inside this issue

  • The Fed Takes Center Stage Once Again
  • Farfetch Limited (FTCH) – A fashionable Living the Life Thematic Leader
  • Digital Lifestyle – The August Retail Sales confirms the adoption continues

 

Economics & Expectations

The Fed Takes Center Stage Once Again

As we saw last week, the primary drivers of the stock market continue to be developments on the U.S.-China trade front and the next steps in monetary policy. As the European Central Bank stepped up its monetary policy loosening, it left some to wonder how much dry powder it had remaining should the global economy slow further and tip into a recession. Amid those concerns, along with some discrepancy among reports that President Trump would acquiesce to a two-step trade deal with China, stocks finished last week with a whimper after rebounding Wednesday and Thursday.

We continue to see intellectual property and national security as key tenets in negotiating a trade deal with China. We will watch as the lead up to October’s next round of trade negotiations unfolds. Given the Fed’s next two-day monetary policy meeting that begins on Tuesday and culminates with the Fed’s announcement and subsequent press conference, barring any new U.S.-China trade developments before then, it’s safe to say what the Fed says will be a key driver of the stock market this week.

Leading up to that next Fed press conference, we will get the August data for Industrial Production and Housing Starts as well as the September Empire State Manufacturing Index. Paired with Friday’s August Retail Sales report and last Thursday’s August CPI report, that will be some of the last data the Fed factors into its policy decision.

Per the CME Group’s FedWatch tool, the market sees an 82% probability for the Fed to cut interest rates by 25 basis points this week with possibly one more rate cut to be had before we exit 2019. Normally speaking, parsing the Fed’s words and Fe Chair Powell’s presser commentary are key to getting inside the central bank’s “head,” and this will be especially important this time around. One of our concerns has been the difference between the economic data and the expectations it is yielding in the stock market. Should the Fed manage to catch the market off guard, odds are it will give the market a touch of agita.

On the earnings front

there are five reports that we’ll be paying close attention to this week. They are Adobe Systems (ADBE), Chewy (CHWY), FedEx (FDX), General Mills (GIS) and Darden Restaurants (DRI). With Adobe, we’ll be examining the rate of growth tied to cloud, an aspect of our Disruptive Innovators investing theme. With Darden we’ll look to see if the performance at its full-service restaurants matches up with the consumer trade-down data being reported by the National Restaurant Association. That data has powered shares of Cleaner Living Thematic Leader and Cleaner Living Index resident Chipotle Mexican Grill (CMG) higher of late, bringing the year to date return to 82% vs. 20% for the S&P 500. Chewy is a Digital Lifestyle company that is focused on the pet market serving up food, toys, medications and other pet products. Fedex will not only offer some confirmation on the digital shopping aspect of our Digital Lifestyle investing theme it will also shed some light on the global economy as well.

 

Farfetch Limited – A fashionable Living the Life Thematic Leader

In last week’s issue, I mentioned that I was collecting my thoughts on Farfetch Limited (FTCH), a company that sits at the intersection of the luxury goods market and digital commerce. Said thematically, Farfetch is a company that reflects our Living the Life investment theme, while also benefitting from tailwinds of our Digital Lifestyle theme. Even though the company went public last year, it’s not a household name even though it operates a global luxury digital marketplace. As the shares have fallen over the last several weeks, I’ve had my eyes on them and now is the time to dip our toes in the water by adding FTCH as a Thematic Leader.

 

 

Farfetch Provides Digital Shopping to the Exploding Global Luxury Market

Farfetch is a play on the global $100 billion online luxury market with access to over 3,200 different brands across more than 1,100 brand boutique partners across its platform. With both high-end and every-day consumers continuing to shift their shopping to online and mobile platforms, we see Farfetch attacking a growing market that also has the combined benefit of appealing to the aspirational shopper and being relatively inelastic compared to mainstream apparel.

Part of what is fueling the global demand for luxury and aspirational goods is the rising disposable income of consumers in Asia, particularly China. According to Hurun’s report, The Chinese Luxury Traveler, enthusiasm for overseas travel shows no signs of abating, with the proportion of time spent on overseas tourism among luxury travelers increasing 5% to become 70% of the total. Cosmetics, (45%), local specialties (43%), luggage (39%), clothing and accessories (37%) and jewelry (34%) remain the most sought — after items among luxury travelers. High domestic import duties and concerns about fake products contribute to the popularity of shopping abroad.

It should come as little surprise then that roughly 31% of FarFetch’s 2018 revenue was derived from Asia-Pacific with the balance split between Europe, Middle East & Africa (40%) and the Americas (29%). At the end of the June 2019 quarter, the company had 1.77 million active customers, up from 1.35 million exiting 2018 and 0.9 million in 2017. As the number of active users has grown so too has Farfetch’s revenue, which hit $718 million over the 12 months ending June 2019 compared to $602 million in all of 2018 and $386 million in 2017.

Farfetch primarily monetizes its platform by serving as a commercial intermediary between sellers and end consumers and earns a commission for this service. That revenue stream also includes fees charged to sellers for other activities, such as packaging, credit-card processing, and other transaction processing activities. That business accounts for 80%-85% of Farfetch’s overall revenue with the balance derived from Platform Fulfillment Revenue and to a small extent In-Store Revenue.

New Acquisition Transformed Farfetch’s Revenue Mix 

In August, Farfetch announced the acquisition of New Guards Group, the Milan-based parent company of Off-White, Heron Preston and Palm Angels, in a deal valued at $675 million. New Guards will serve as the basis for a new business segment at Farfetch, one that it has named Brand Platform. Brand Platform will allow Farfetch to leverage New Guards’ design and product capabilities to expand the reach of its brands as well as develop new brands that span the Farfetch platform. For the 12-month period ending April 2019, the New Guards portfolio delivered revenue of $345 million, with profits before tax of $95 million. By comparison, Farfetch posted $654 million in revenue and an operating loss of $183 million over that time frame.

Clearly, another part of the thought behind acquiring New Guards and building the Brand Platform business is to improve the company’s margin and profit profile. And on the housekeeping front, the $675 million paid for New Guards will be equally split between cash and stock. Following its IPO last year, Farfetch ended the June quarter with roughly $1 billion in cash and equivalents on its balance sheet.

In many ways what we have here is a baby Amazon (AMZN) that is focused on luxury goods. Ah, the evolution of digital shopping! And while there are a number of publicly traded companies tied to digital shopping, there are few that focus solely on luxury goods.

Why Now is the Time to Add FTCH Shares

We are heading into the company’s seasonally strongest time of year, the holiday shopping season, and over the last few years, the December quarter has accounted for almost 35% of Farfetch’s annual sales. With the company’s active user base continuing to grow by leaps and bounds, that historical pattern is likely to repeat itself. Current consensus expectations have Farfetch hitting $964 million in revenue for all of 2019 and then $1.4 billion in 2020.

At the current share price, FTCH shares are trading at 1.6x expected 2020 sales on an enterprise value-to-sales basis. The consensus price target among the 10 Wall Street analysts that cover the stock is $22, which equates to an EV/2020 sales multiple of near 3.5x when adjusting for the pending New Guards acquisition. As we move through this valuation exercise, we have to factor into our thinking that Farfetch is not expected to become EBITDA positive until 2021. In our view, that warrants a bit of haircut on the multiple side and utilizing an EV/2020 sale multiple of 2.5x derives our $16 price target.

  • Despite that multiple, there is roughly 60% potential upside to that target vs. downside to the 52-week low of $8.82.
  • We are adding FTCH shares to the Thematic Leaders for our Living the Life investing theme.
  • A $16 price target is being set and we will wait to put any sort of stop-loss floor in place.

 

Digital Lifestyle – The August Retail Sales confirms the adoption continues

One of last week’s key economic reports was the August Retail Sales report due in part to the simple fact the consumer directly or indirectly accounts for two-thirds of the domestic economy. Moreover, with the manufacturing and industrial facing data – both economic and other third-party kinds, such as truck tonnage, railcar loadings and the like – softening in the June quarter, that quarter’s positive GDP print hinged entirely on the consumer. With domestic manufacturing and industrial data weakening further in July and August, the looming question being asked by many an investor is whether the consumer can keep the economy chugging along?

In recent months, I’ve voiced growing concerns over the spending health of the consumer as more data suggests a strengthening tailwind for our Middle-Class Squeeze investing theme. Some of that includes the Federal Reserve Bank of New York’s latest Household Debt and Credit Report, consumer household debt balances have been on the rise for five years and quarterly increases continue on a consecutive basis, bringing the second quarter 2019 total to $192 billion. Also a growing number of banks are warning over rising credit card delinquencies even as the Federal Reserve’s July Consumer Credit data showed revolving credit expanded at its fastest pace since November 2017.

Getting back to the August Retail Sale report, the headline print was a tad better than expected, however once we removed auto sales, retail sales for the month were flat. That’s on a sequential basis, but when viewed on a year over year one, retail sales excluding autos rose 3.5% year over year. That brought the year over year comparison for the three-months ending with August to up 3.4% and 1.5% stronger than the three months ending in May on the same basis.

Again, perspective can be illuminating when looking at the data, but what really shined during the month of August was digital shopping, which rose 16.0% year over year. That continued strength following the expected July surge in digital shopping due to Amazon Prime Day and all the others that looked to cash in on it led year over year digital shopping sales to rise 15.0% for the three months ending in August.

Without question, this aspect of our Digital Lifestyle investing theme continues to take consumer wallet share, primarily at the expense of brick & mortar retailers, especially department stores, which saw their August retail sales fall 5.4%. That continues the pain felt by department stores and helps explain why more than 7,000 brick & mortar locations have shuttered their doors thus far in 2019. Odds are there is more of that to come as consumers continue to shift their dollar purchase volume to online and mobile shopping as Walmart (WMT), Target (TGT) and others look to compete with Amazon Prime’s one day delivery.

  • For all the reasons discussed above, Amazon remains our Thematic King as we head into the seasonally strong holiday shopping season. 

 

Ep 15 Trump and Trade, Apple event thoughts and Volkswagen swings at Tesla

Ep 15 Trump and Trade, Apple event thoughts and Volkswagen swings at Tesla

On this episode of the Thematic Signals podcast, Tematica’s Chris Versace breaks down the latest trade developments (including why he doesn’t think a two-step deal is likely) and discusses the European Central Bank rate cut before shares his thoughts on the continued plight of brick & mortar retail as Forever 21 is slated to file bankruptcy this weekend. We see no slowdown in the Digital Lifestyle tailwind that is a headwind for those like Forever 21. Chris then moves to why he was nonplused by Apple’s 2019 iPhone event even though it announcements made during the event mean problems for Netflix and GameStop. Also, hotels in Japan get a makeover, and Volkswagen comes out of the German Auto Show swinging at Tesla. To hear how those two items tie into our Living the Life and Cleaner Living investing themes, as well as why Chris is a little concerned about the Federal Reserve meeting next week, you’ll need to hit the play button and listen.

Have a topic or a conversation you think we should tackle on the podcast, email me at cversace@tematicaresearch.com

And don’t forget to subscribe to the Thematic Signals Podcast on iTunes!

 

Resources for this podcast:

Weekly Issue: Key Developments at Apple (AAPL) and AT&T (T)

Weekly Issue: Key Developments at Apple (AAPL) and AT&T (T)

Key points inside this issue:

  •  Apple’s 2019 iPhone event – more meh than wow
  •  GameStop – It’s only going to get worse
  •  Elliot Management gets active in AT&T, but its prefers Verizon?
  •  California approves a bill that changes how contract workers are treated
  • Volkswagen set to disrupt the electric vehicle market

I’m going to deviate from the usual format we’ve been using here at Tematica Investing this week to focus on some of what’s happening with Select List residents Apple (AAPL) and AT&T (T) this week as well as one or two other things. The reason is the developments at both companies have a few layers to them, and I wanted to take the space to discuss them in greater detail. Don’t worry, we’ll be back to our standard format next week and I should be sharing some thoughts on Farfetch (FTCH), which sits at the crossroads of our Living the Life, Middle Class Squeeze and Digital Lifestyle investing themes, and another company I’ve been scrutinizing with our thematic lens. 

 

Apple’s 2019 iPhone event – more meh than wow

Yesterday, Apple (AAPL) held its now annual iPhone-centric event, at which it unveiled its newest smartphone model as well as other “new”, or more to the point, upgraded hardware. In that regard, Apple did not disappoint, but the bottom line is the company delivered on expectations serving up new models of the iPhone, Apple Watch and iPad, but with only incremental technical advancements. 

Was there anything that is likely to make the average users, not the early adopter, upgrade today because they simply have to “have it”? 

Not in my view. 

What Apple did do with these latest devices and price cuts on older models that it will keep in play was round out price points in its active device portfolio. To me, that says CEO Tim Cook and his team got the message following the introduction of the iPhone XS and iPhone XS Max last year, each of which sported price tags of over $1,000. This year, a consumer can scoop up an iPhone 8 for as low as $499 or pay more than $1,000 for the new iPhone 11 Pro that sports a new camera system and some other incremental whizbangs. The same goes with Apple Watch – while Apple debuted a new Series 5 model yesterday, it is keeping the Series 3 in the lineup and dropped its price point to $199. That has the potential to wreak havoc on fitness trackers and other smartwatch businesses at companies like Garmin (GRMN) and Fitbit (FIT). 

Before moving on, I will point out the expanded product price points could make judging Apple’s product mix revenue from quarter to quarter more of a challenge, especially since Apple is now sharing information on these devices in a more limited fashion. This could mean Apple has a greater chance of surprising on revenue, both to the upside as well as the downside. Despite Apple’s progress in growing its Services business, as well its other non-iPhone businesses, iPhone still accounted for 48% of June 2019 quarterly revenue. 

Those weren’t the only two companies to feel the pinch of the Apple event. Another was Netflix (NFLX) as Apple joined Select List resident Walt Disney (DIS) in undercutting Netflix’s monthly subscription rate. In case you missed it, Disney’s starter package for its video streaming service came in at $6.99 per month. Apple undercut that with a $4.99 a month price point for its forthcoming AppleTV+ service, plus one year free with a new device purchase. To be fair, out of the gate Apple’s content library will be rather thin in comparison to Disney and Netflix, but it does have the balance sheet to grow its library in the coming quarters. 

Apple also announced that its game subscription service, Apple Arcade, will launch on September 19 with a $4.99 per month price point. Others, such as Microsoft (MSFT) and Alphabet (GOOGL) are targeting game subscription services as well, but with Apple’s install base of devices and the adoption of mobile gaming, Apple Arcade could surprise to the upside. 

To me, the combination of Apple Arcade and these other game services are another nail in the coffin for GameStop (GME). 

 

GameStop – It’s only going to get worse

I’ve been bearish on GameStop (GME) for some time, but even I didn’t think it could get this ugly, this fast. After the close last night, GameStop reported its latest quarter results that saw EPS miss expectations by $0.10 per share, a miss on revenues, guidance on its outlook below consensus, and a cut to its same-store comps guidance. The company also shared the core tenets of a new strategic plan. 

Nearly all of its speaks for itself except for the strategic plan. Those key tenets are:

  • Optimize the core business by improving efficiency and effectiveness across the organization, including cost restructuring, inventory management optimization, adding and growing high margin product categories, and rationalizing the global store base. 
  • Create the social and cultural hub of gaming across the GameStop platform by testing and improving existing core assets including the store experience, knowledgeable associates and the PowerUp Rewards loyalty program. 
  • Build digital capabilities, including the recent relaunch of GameStop.com.
  •  Transform vendor and partner relationships to unlock additional high-margin revenue streams and optimize the lifetime value of every customer.

Granted, this is a cursory review, but based on what I’ve seen I am utterly unconvinced that GameStop can turn this boat around. The company faces headwinds associated with our Digital Lifestyle investing theme that are only going to grow stronger as gaming services from Apple, Microsoft and Alphabet come to market and offer the ability to game anywhere, anytime. To me, it’s very much like the slow sinking ship that was Barnes & Noble (BKS) that tried several different strategies to bail water out. 

Did GameStop have its time in the sun? Sure it did, but so did Blockbuster Video and we all know how that ended. Odds are it will be Game Over for GameStop before too long.

Getting back to Apple, now we wait for September 20 when all the new iPhone models begin shipping. Wall Street get your spreadsheets ready!

 

Elliot Management gets active in AT&T, but its prefers Verizon?

Earlier this week, we learned that activist investor Elliot Management Corp. took a position in AT&T (T). At $3.2 billion, we can safely say it is a large position. Following that investment, Elliot sent a 24-page letter telling AT&T that it needed to change to bolster its share price. Elliot’s price target for T shares? $60. I’ll come back to that in a bit. 

Soon thereafter, many media outlets from The New York Times to The Wall Street Journal ran articles covering that 24-page letter, which at one point suggested AT&T be more like Verizon (VZ) and focus on building out its 5G network and cut costs. While I agree with Elliot that those should be focus points for AT&T, and that AT&T should benefit from its spectrum holdings as well as being the provider of the federally backed FirstNet communications system for emergency responders, I disagree with its criticism of the company’s media play. 

Plain and simple, people vote with their feet for quality content. We’ve seen this at the movie box office, TV ratings, and at streaming services like Netflix (NFLX) when it debuted House of Cards or Stranger Things, and Hulu with the Handmaiden’s Tale. I’ve long since argued that AT&T has taken a page out of others’ playbook and sought to surround its mobile business with content, and yes that mobile business is increasingly the platform of choice for consuming streaming video content. By effectively forming a proprietary content moat around its business, the company can shore up its competitive position and expand its business offering rather than having its mobile service compete largely on price. And this isn’t a new strategy – we saw Comcast (CMCSA) do it rather well when it swallowed NBC Universal to take on Walt Disney and others. 

Let’s also remember that following the acquisiton of Time Warner, AT&T is poised to follow Walt Disney, Apple and others into the streaming video service market next year. Unlike Apple, AT&T’s Warner Media brings a rich and growing content library but similar to Apple, AT&T has an existing service to which it can bundle its streaming service. AT&T may be arriving later to the party than Apple and Disney, but its effort should not be underestimated, nor should the impact of that business on how investors will come to think about valuing T shares. The recent valuation shift in Disney thanks to Disney+ is a great example and odds are we will see something similar at Apple before too long with Apple Arcade and AppleTV+. These changes will help inform us as to how that AT&T re-think could play out as it comes to straddle the line between being a Digital Infrastructure and Digital Lifestyle company.

Yes Verizon may have a leg up on AT&T when it comes to the current state of its 5G network, but as we heard from specialty contractor Dycom Industries (DY), it is seeing a significant uptick in 5G related construction and its top two customers are AT& T (23% of first half 2019 revenue) followed by Verizon (22%). But when these two companies along with Sprint (S), T-Mobile USA (TMUS) and other players have their 5G network buildout competed, how will Verizon ward off subscriber poachers that are offering compelling monthly rates? 

And for what it’s worth, I’m sure Elliot Management is loving the current dividend yield had with T shares. Granted its $60 price target implies a yield more like 3.4%, but I’d be happy to get that yield if it means a 60% pop in T shares. 

 

California approves a bill that changes how contract workers are treated

California has long been a trend setter, but if you’re an investor in Uber (UBER) or Lyft (LYFT) — two companies riding our Disruptive Innovators theme — that latest bout of trend setting could become a problem. Yesterday, California lawmakers have approved Assembly Bill 5, a bill that requires companies like Uber, Lyft and DoorDash to treat contract workers as employees. 

This is one of those times that our thematic lens is being tilted a tad to focus on a regulatory change that will entitle gig workers to protections like a minimum wage and unemployment benefits, which will drive costs at the companies higher. It’s being estimated that on-demand companies like Uber and the delivery service DoorDash will see their costs rise 20%-30% when they rely on employees rather than contractors. For Uber and Lyft, that likely means pushing out their respective timetables to profitability.

We’ll have to see if other states follow California’s lead and adopt a similar change. A coalition of labor groups is pushing similar legislation in New York, and bills in Washington State and Oregon could see renewed momentum. The more states that do, the larger the profit revisions to the downside to be had. 

 

Volkswagen set to disrupt the electric vehicle market

It was recently reported that Volkswagen (VWAGY) has hit a new milestone in reducing battery costs for its electric vehicles, as it now pays less than $100 per KWh for its batteries. Given the battery pack is the most expensive part of an electric vehicle, this has been thought to be a tipping point for mass adoption of electric vehicles. 

Soon after that report, Volkswagen rolled out the final version of its first affordable long-range electric car, the ID.3, at the 2019 Frankfurt Motor Show and is expected to be available in mid-2020.  By affordable, Volkswagen means “under €30,000” (about $33,180, currently) and the ID.3 will come in three variants that offer between roughly 205 and 340 miles of range. 

By all accounts, the ID.3 will be a vehicle to watch as it is the first one being built on the company’s new modular all-electric platform that is expected to be the basis for dozens more cars and SUVs in the coming years as Volkswagen Group’s pushed hard into electric vehicles. 

Many, including myself, have been waiting for the competitive landscape in the electric vehicle market to heat up considerably – it’s no secret that all the major auto OEMs are targeting the market. Between this fall in battery cost and the price point for Volkswagen’s ID.3, it appears that the change in the landscape is finally approaching and it’s likely to bring more competitive pressures for Clean Living company and Cleaner  Living Index constituent Tesla (TSLA). 

 

A Fixed Income View on the Current Market

A Fixed Income View on the Current Market


A look into today’s market through a fixed income lens with Peter Tchir of Academy Securities




On this episode of the Thematic Signals podcast, host Chris Versace is joined by Peter Tchir, who is the Head of Macro Strategy at Academy Securities. While Chris has a thematic focus, Peter’s is from the fixed income vantage point, which means he tends to focus on credit and risk. Despite the different approaches, the two discuss the US-China trade war, the swath of recent economic data and prospects for further monetary policy stimulus from both the European Central Bank and the Federal Reserve. As they talk, Peter shares his views on why a US-China trade deal won’t be reached until the first half of 2020, why he’s not as concerned about the inverted yield curve, why fund flows into low volatility funds are a concern of his and the reason why he thinks Turkey could be the unexpected issue that upsets the apple cart in the coming months. 

Have a topic or a conversation you think we should tackle on the podcast, email me at cversace@tematicaresearch.com

And don’t forget to subscribe to the Thematic Signals Podcast on iTunes!

Resources for this podcast:

Weekly Issue: September Looks Like a Repeat of August

Weekly Issue: September Looks Like a Repeat of August

Key points inside this issue

  • We are establishing a buy-stop level at 9.50 for shares of Veeco Instruments (VECO), which will lock in a profit of at least 13% on this short position.
  • The Hershey Company: Tapping into Cleaner Living with M&A


We ended a volatile August… 

Stocks rebounded from some of their recent losses last week as trade tensions between the U.S. and China appear to have cooled off a bit. For the month of August in total, during which there seemed to be one market crisis after another, most of the major stock market indices finished down slightly. The outlier was the small-cap heavy Russell 2000, which shed around 5% during the month.

Looking back over the last few weeks, the market was grappling with a number of uncertainties, the most prominent of which was the announced tariff escalation in the U.S- China trade war. There were other uncertainties brewing, including the growing number of signs that outside of consumer spending, the economy continues to soften. We saw that consumer strength in Friday’s July Personal Income & Spending data, but also in the second June-quarter GDP revision that ticked down to 2.0% from 2.1%, even though estimates for consumer spending during the quarter rose to 4.7% from 4.3%. I would note that 4.7% marked the strongest level of consumer spending since the December 2014 quarter. We are, however, seeing a continued shift in where consumers are spending — moving from restaurants and department stores to quick-service restaurants and discount retailers as well as online. This raises the question as to whether the economy is prepared to meet head-on our Middle Class Squeeze investing theme?

Another issue investors grappled with as we closed out August was the yield curve inversion. While historically this does raise a red flag, it’s not a foregone conclusion that a recession is around the corner. Rather it can be several quarters away, and there are several stimulative measures that could be invoked to keep the economy growing. In other words, we should continue to mind the data and any potential monetary policy tweaking to be had.

Closing out August, more than 99% of the S&P 500 have reported earnings for the June-quarter season. EPS for that group rose just under 1%, which was far better than the contraction that was lining up just a few weeks ago. Based on corporate guidance and other factors, however, EPS expectations for both the September and December quarters have been revised lower. Some of this no doubt has to do with the next round of tariffs that took effect on Sept. 1 on Chinese imports, but we can’t dismiss the slowing speed of the global economy either.

That overall backdrop of uncertainty helps explain why the three best-performing sectors during August were Utilities, Real Estate and Consumer Staples. But as we saw in the second half of last week, a softer tone on the trade war led investors back into the market as China said it wished to resolve the trade dispute with a “calm” attitude.

Without question, investors and Corporate America are eager for forward progress on the trade war to materialize. While there have been several head fakes in recent months, we should remain optimistic. That said, we here at Tematica continue to believe the devil will be in the details when it comes to a potential trade agreement, and much like deciphering economic data, it will mean digging into that agreement to fully understand its ramifications. Those findings and their implications as well as what we hear on the monetary policy front will set the stage for what comes next. 


… and it looks like more ahead for September

This week kicks off the last month of the third quarter of 2019. For many, it will be back to work following the seasonally slow, but volatile last few weeks of summer. The question to be pondered is how volatile will September be? Historically speaking it is the worst calendar month for stocks and based on yesterday’s performance it is adhering to its reputation.

As a reminder, on Sept. 1 President Trump authorized a tariff increase to 15% from 10% on $300 billion in Chinese imports, many of which are consumer goods such as clothing, footwear and electronics.  As we saw, that line in the sand came and went over the holiday weekend and now Trump is once again rattling his trade saber, suggesting China should make a deal soon as it will only get worse if he wins the 2020 presidential election.

In addition to that, yesterday morning we received the one-two punch that was the August reading on the manufacturing economy — from both IHS Markit and the Institute of Supply Management. The revelation that manufacturing continued to slow weighed on stocks yesterday. The direction of Tuesday’s official data, however, was not a surprise to us given other data we monitor such as weekly rail car loadings, truck tonnage and the Cass Freight Index.  But as I have seen many a time, just because we are aware of something in the data doesn’t mean everyone is. 

What I suspect has rattled the market as we kick off September is the August ISM Manufacturing Survey, which showed the U.S. manufacturing sector declined to 49.1 in August. That is the lowest reading in about three years, and as a reminder, any reading below 50 signals a contraction. Data from IHS Markit also released yesterday showed the U.S. manufacturing PMI slowed to 50.3 in August, its lowest level since September 2009. Slightly better than the ISM headline print, but still down. Digging into both reports, we see new orders stalled, which suggests businesses are not only growing wary of the trade uncertainty, but that we should not expect a pickup in the month of September.

In my view, the more official data is catching up to the “other data” cited earlier and that more than likely means downward gross domestic product expectations ahead. It will also lead the market to focus increasingly on what the Fed will do and say later this month. I also think the official data is now capturing the weariness of the continued trade war. The combination of the slowing economy as well as the continued if not arguably heightened trade uncertainty will more than likely lead to restrain spending and investment in Corporate America, which will only add to the headwinds hitting the economy. 

Taking those August manufacturing reports, along with the data yet to come this week – the ISM Non-Manufacturing readings for August, and job creation data for August furnished by ADP and the Bureau of Labor Statistics — we’ll be able to zero in on the GDP taking shape in the current quarter. I would note that exiting last week, the NY Fed’s Nowcast reading for the September quarter was 1.76%, below the 2.0% second revision for June-quarter GDP. There is little question that given yesterday’s data the next adjustment to those forecasts will be lower. 

Adding to that view, we’ll also get the next iteration of the Fed’s Beige Book, which will provide anecdotal economic commentary gathered from the Fed’s member banks. And following the latest data, we can expect investors and economists alike will indeed be pouring over the next Beige Book.

No doubt, all of this global macro data and the trade war will be on the minds of central bankers ahead of their September meetings. Those dates are Sept. 12 for the European Central Bank (ECB) followed by the Fed’s next monetary policy meeting and press conference on Sept. 16-17. Given the declines in the eurozone, the ECB is widely expected to announce a stimulus package exiting that meeting, and currently the CBOE FedWatch Tool pegs a 96% chance of a rate cut by the Fed. With those consensus views in mind, should the economic data paint a stronger picture than expected it could call into question those likelihoods. If central banker expectations fail to live up to Wall Street expectations, that would more than likely give the stock market yet another case of indigestion. 

All of this data will also factor into earnings expectations. Earlier I mentioned some of the more recent revisions to the downside for the back half of 2019 but as we know this is an evolving story. That means effectively “wash, rinse, repeat” when it comes to assessing EPS growth for the S&P 500 as well as individual companies. And lest we forget, companies will not only have to contend with the effect of the current trade war and slowing economy on their businesses, but also the dollar, which as we can see in the chart below has near fresh highs for 2019. 

The biggest risk I see over the next few weeks is one of economic, monetary policy and earnings reality not matching up with expectations. Gazing forward over the next few weeks, the growing likelihood is one that points more toward additional risk in the market. We will continue to trade carefully in the near-term and heed what we gather from the latest thematic signals.


The Thematic Leaders and Select List

Over the last several weeks, the market turbulence led several positions, including those in Netflix (NFLX), Dycom (DY) and International Flavors & Fragrances (IFF) — on both the Tematica Leader board and the Select List to be stopped out. On the other hand, even though the overall markets took a bit of a nosedive during August, several of our thematic holdings, such as USA Technologies (USAT), AT&T (T), Costco Wholesale (COST), McCormick & Co. (MKC) and Applied Materials (AMAT) to name a few outperformed on both an absolute and relative basis.

Even the short position in Veeco Instruments (VECO) has returned nearly 18% since we added that to the Select List last March. That has been a particularly nice move, but also one that is playing out as expected. Currently, we have do not have a buy-stop order to protect us on our VECO position, and we are going to rectify that today. We are establishing a buy-stop level at 9.50 for shares of Veeco Instruments (VECO), which will lock in a profit of at least 13% on this short position. 

  • We are establishing a buy-stop level at 9.50 for shares of Veeco Instruments (VECO), which will lock in a profit of at least 13% on this short position.


The Hershey Company: Tapping into Cleaner Living with M&A

When we think of The Hershey Company (HSY) there is little question that its candy, gum and mints business that garnered it just over 30% of the US candy market lands its squarely in our Guilty Pleasure investing theme. Even the company itself refers to itself as the “undisputed leader in US confection” and we look at its thematic scorecard rankings, its business warrants a “5”, which means nearly all of its sales and profits are derived from our Guilty Pleasure theme. 

Not exactly a shock to even a casual observer. 

But as we’ve discussed more than a few times, consumers are shifting their preferences for food, beverages and snacks to “healthier for you” alternatives. These could be offerings made from organic or all-natural ingredients, or even ingredients that are considered to promote better health, such as protein over sugar. Recognizing this changing preference among its core constituents, Hershey hasn’t been asleep at the switch, but rather it has been making a number of nip and tuck acquisitions to improve its snacking portfolio, which aligns well with our Cleaner Living investing theme. 

These acquisitions have played out over a number of years, starting with the acquisition of the Krave jerky business (2015);  SkinnyPop parent Amplify Snacks (2017), Pirate Brands, including the Pirate’s Booty, Smart Puffs and Original Tings brands (2018). Then, just last month, Hershey acquired ONE Brands, LLC, the maker of a line of low-sugar, high-protein nutrition bars. August 2019 turned out to be a busy month for the executives of Hershey, as also in that month, the company announced minority investments in emerging snacking businesses FULFIL Holdings Limited and Blue Stripes LLC. FULFIL is a one of the leading makers of vitamin–fortified, high protein nutrition bars in the UK and Ireland, while Blue Stripes offers cacao-based snacks and treats instead of chocolate ones. 

Clearly the Hershey Company is improving its position relative to our Cleaner Living investing theme. The outstanding question is to what degree are these aggregated businesses contributing to the company’s overall sales and profits? While it is safe to say Hershey has some exposure to the Cleaner Living theme, the answers to those questions will determine Hershey’s overall theme ranking. That level of detail could emerge during the company’s September quarter earnings call, but it may not until it files its 2019 10-K. 

As we wait for that October conference call, I’ll continue to do some additional work on HSY shares, including what the potential EPS impact is from not only falling sugar prices but also the pickup in cocoa prices over the last six months. In a surprise that should come to no one, given the size and influence of the company’s chocolate and confectionary business to its sales and profits, cocoa and sugar are two key inputs that can hold sway over the Hershey cost structure. 

In my mind, the long-term question with Hershey is whether it can replicate the nip and tuck transformative success Walmart (WMT) had when it used a similar strategy to reposition itself to better capture the tailwinds of our Digital Lifestyle investing theme? No doubt transformation takes time, but now is the time to see if a better business balance between our Guilty Pleasure and Cleaner Living themes emerges at Hershey.

Weekly Issue: As Global Economy Slows, Investors Switch into Fear Mode

Weekly Issue: As Global Economy Slows, Investors Switch into Fear Mode


Key points inside this issue

  • The global economy continued to slow in August
  • Uncertainty has investors in Extreme Fear mode
  • Trade remains the focus of the stock market
  • Boosting our Disney (DIS) price target following D23’s Disney+ focus
  • Items to watch this week


The stock market has been a more volatile than usual over the last few weeks as investors:

  • Contend with the latest global economic data
  • Eye the yield curve
  • Question what the Fed will do next
  • Brace for the next round of trade talks

As if that wasn’t enough, we’ve also witnessed mixed June quarter retail earnings, which are now getting factored into second half of 2019 earnings-per-share expectations for the S&P 500. At the same time, the velocity of corporate buybacks has slowed, Washington is scrutinizing tech companies, and consumer confidence is waning. 

All in all, these issues weighing on investors minds have led to swings in the market based on the most recent headlines, and that can make for a challenging time in the market and for investors.


The global economy continued to slow in August

Last Thursday morning, we received the first meaningful piece of August economic data in the form of the IHS Markit Flash PMI data for the month, and in aggregate, it confirms the global economic slowdown. To date, the U.S. has been the best house on the slowing economic block, but Thursday’s data, which showed the domestic manufacturing sector contracting for the first time in a decade means the trade war and uncertain environment are weighing on the economy. 

During periods of uncertainty, whether we’re talking about companies or people, the natural instinct is to pull back, wait and assess the situation. For both people and companies, dialing back spending is an arguable course of action when faced with uncertainty, but from an economic perspective that translates into a headwind for growth. We’re seeing that headwind in the day’s Flash PMI data.

Aside from the headline, U.S. Flash Manufacturing PMI hit 49.9, marking a 119-month low; the index’s new orders component put in its weakest reading since 2009. Per the report, “Survey respondents often cited subdued corporate spending in response to softer business conditions and concerns about the global economic outlook.” 

But as we saw with the July Retail Sales report, consumers continue to spend, despite rising debt levels and banks are starting to report a pick-up in delinquency rates. The question that is coming to the forefront of investor minds is whether consumers will be able to spend and keep the economy chugging along during the all- important holiday shopping season that will soon be upon us? Given the continued increase in consumer debt levels and news that Citibank (C), JPMorgan Chase (JPM), Bank of America (BAC) and other banks are reporting rising credit card delinquency rates we could be starting to see the consumer spending breaking point. 

Looking at the August Flash PMI data for the eurozone, the slowdown continued as well, but the report also registered a “sizeable drop in confidence regarding the 12-month outlook” with sentiment down to its lowest level since May 2013. Digging into that report we find new order growth in Germany, the largest economy in the eurozone, falling to its weakest levels since early 2013. The August data for the region confirms current forecasts the region is likely to hit just 0.1%-0.2% Gross Domestic Product in the current quarter. Another round of weak data, and odds are we’ll soon see recession fears rising ahead of the European Central Banks upcoming mid-September monetary policy meeting.


Uncertainty has investors in Extreme Fear mode

If we were to step back and look at the data, what we are seeing is data that points to a continued slowdown with some bright spots. Granted those bright spots are also somewhat mixed and there are reasons to be concerned over the sustainability of those bright spots. Is it any wonder then that the CNN Money Fear & Greed Index has been firmly in “Extreme Fear” for the last week? In a word, no.

During periods of Extreme Fear, the jittery market is bound to overreact. Add in the fact that we are in one of the seasonally slowest times of the year for trading volumes means market reactions will be even more extreme one way or another. The danger for investors is to get caught up in the turbulence, and it can be rather easy to do, especially if one is looking to pile onto a money-making trade, be it a long or short one. This makes headline-grabbing, bold assertions increasingly digestible, like the one from hedge fund hired-gun Harry Markopolos on General Electric (GE) or rumor–mongering like the recent one that drove the recent pop in shares of Tesla Motors (TSLA).

Rumors and assertions are tricky things, and while some may turn out to be true, others may only have a whisper of truth, if any at all. In the case of Markopolos, he’s working with an unnamed hedge fund partner, and while it would be wrong to cast wide dispersion on the industry, the reality is it is hurting. In 2018, eVestment hedge fund performance data showed the overall hedge fund industry returned negative 5.08%. While the industry is in positive territory on a year-to-date basis this year, it still meaningfully lags the major market indexes.

The bottom line is that in a market environment that is teaming with uncertainty on several sides, it is even more important that investors continue to focus on the data rather than be led astray by rumors and conjecture. Whether it is digging into a company’s financial filings; cross referencing conference call transcripts across a company’s competitors, customers and suppliers; or wading deep into the economic data, now more than ever it is important to do the homework rather than simply piling onto an idea that could simply be one person talking his or her trade book.  In our case, we’ll continue to assess and revisit the tailwinds that powers each of our investing themes each week through Thematic Signals and our Thematic Reading as well as our Thematic Signals podcast. 

Along the way, we may find something that helps put some of those potentially over-the- top assertions into perspective. One such example is found in the work by Bronte Capital that took Markopolos’ assertion that GE’s industrial margins near 15% are “too good to be true” to task by comparing them with similar margins at Honeywell (HON), Emerson Electric (EMR) and others. Once again, digging into the data adds that layer of context and perspective that is both helpful and insightful to investors.

In my experience, making a trade without doing the homework first and getting conviction on the thesis rarely yields the hopium expected. If the homework checks out, it offers confidence and conviction in the position. Periodically checking the data to determine if that thesis remains on track can either keep one’s conviction running high or alert to a potential issue. Not doing the homework leaves one vulnerable to a change they might not even known was coming.


Trade remains the focus on the stock market

As we approached the end of last week, the stock market was poised to move higher week over week, but as we saw it finished up on a very different note given all of Friday’s news. That news spanned from China threatening countermeasures on tariffs set to be instilled on Sept. 1, to the Fed being ready to extend the current recovery even though it remains upbeat about the domestic economy, to President Trump “ordering” U.S. companies to look for “alternative to China” and then raising tariffs on China after the market close. 

There was little question, we were once again seeing U.S.-China trade tensions escalate, raising questions as to what it could mean for the next round of trade talks. In other words, as we headed into one of the last summer weekends, U.S.-China trade uncertainty continued. While the market absorbed China’s escalation and Fed Chair Powell’s “at the ready when needed” comment, it was Trump’s latest trade salvo that reversed the market’s direction for the week leading all the major stock indices to finish down for the week. Trump said he would raise existing duties on $250 billion in Chinese products to 30% from 25% on October 1 and increase the 10% tariff on another $300 billion of Chinese goods set to take effect on September 1 to 15%.

The trade drama at the G-7 meeting continued over the weekend, and it appeared the market was going to start this week off with more than a whimper given that last night US stock market futures were down more than 1%. However, like any good drama that has a number of twists, this morning President Trump shared that China wants to make a trade deal, which served to walk back last week’s jump in trade tensions. 

My stance on the trade war has been a combination of hope, patience and details. Hope for a trade deal, patience realizing it would take time to come together and that the details of any trade agreement matter. Despite the purported trade related developments today, my stance remains unchanged. 


Boosting our Disney price target following D23’s Disney+ focus

While many were watching the political and trade events unfold at the G-7 meeting over the weekend, there was another gathering of note – D23 2019 at which Walt Disney (DIS) shared quite a bit about its upcoming Disney+ service that is set to launch on November 12. As I’ve said before, that service not only grows Disney’s exposure to our Digital Lifestyle investing theme, it’s also going to change how Wall Street values both DIS shares as well as those for Netflix (NFLX). 

On its own Disney+ will cost users $6.99 a month, or $69.99 for a full year, but together with ESPN+ and ad-supported Hulu the bundle will run customers $12.99 per month, which is on par with the standard plan offered by Netflix that allows for two screens to be watching at the same time. The starter price for Disney+ allows for up to support for four simultaneous streams with 4K included. That’s quite a difference, and one that runs the risk of eating into Netflix’s business, particularly at the margin as Middle-class Squeeze consumers tally up how much they are spending on all of their streaming video and music as well as other subscription services

During D23 Disney showcased a plethora of Disney+ exclusive content ranging from its Star Wars to Marvel universes. On the Marvel front, Disney+ will include seven live action programs that are expected to tie into the active Marvel Cinematic Universe (MCU) that span existing characters and introduce new ones as well. While some may be missing the original Marvel streaming content that was found on Netflix, the upcoming Marvel content on Disney+ will continue the interlocking nature of the box office films that culminated in this summer’s blockbuster Avengers: Endgame. 

The original programming will be dribbled out over the coming quarters, but at launch Disney+ is expected to contain approximately 7,000 episodes of television series and 400 to 500 movies. According to Disney CEO Bob Iger, almost every single movie in the Disney catalog will eventually be available on the service. That is expected to pale in comparison to the sheer volume of content found on Netflix, which according to Ampere Analysis will be roughly eight times bigger than Disney+’s launch lineup. That may help explain the initial price point for Disney+ but what the service has going for it is it will be the only place one can find some of the biggest franchises in entertainment. That’s very much a page out of the Disney park playbook, and the odds are certainly high that Disney will leverage the content found on Disney+ across its merchandising and park businesses. It was also revealed that Disney and Target (TGT) will partner to open Disney shops inside Target locations, which should only add to the Disney merchandizing business. 

The looming question is to what degree will Disney+ attract subscribers? A far better sense will be had once the service goes live, but that hasn’t stopped Wall Street for putting forth expectations. Wedbush expects Disney to add between 10 million and 15 million subscribers to its service each year until they reach around 45 million. For context, that compares to roughly 60 million Netflix US subscribers and other firms are calling for a faster sign-up rate at Disney+ given the combination of cost and content. 

  • With details surrounding Disney+ becoming clearer, we are boosting our price target on Walt Disney (DIS) shares to $150 from $125. As subscriber data for Disney+ is shared, we’ll continue to refine our price target. 


What to watch this week

On the corporate earnings front this week, the parade of retail earnings will continue with J.Jill (JILL), Chico’s FAS (CHS), Tiffany & Co. (TIF), Best Buy (BBY), Ulta Beauty (ULTA), and Dollar Tree (DLTR) on tap to report, among others. In each of those reports, I’ll be looking for signals relating to our Living the Life, Digital Lifestyle, Aging of the Population, and Middle-class Squeeze investing themes. 

Beyond that cohort, we also have Sanderson Farms (SAFM) reporting and it will be interesting to see what it says about the growing prevalence of meat alternatives that are part of our Cleaner Living investing theme. . Yesterday, Cleaner Living Index company Beyond Meat (BYND) announced it will start testing plant-based fried chicken with YUM Brand’s (YUM) KFC in Atlanta beginning today, August 27. In keeping with that theme, we’ll be comparing and contrasting results at Campbell Soup (CPG) and Hain Celestial (HAIN) given the shifting preference among consumers for healthier foods and snacks. 

Also this week, specialty contractor and one-time Digital Infrastructure Thematic Leader Dycom Industries (DY) will issue its quarterly results and guidance, both of which should offer a view on 5G network buildout for its key customers that include AT&T (T) and Verizon (VZ). Given that Nokia (NOK) shares on the Select List, this will be a report worth digging into.   

While the number of economic data release last week were relatively light, they did pack quite a punch and that continued today with the July Durable Orders Report. While its headline figure showed a better than expected increase, excluding transportation, aircraft and defense to focus on core capital goods the data revealed a 0.4% increase in July, which followed the 0.9% increase in June. Sucking some of the air out of that improvement, core capital goods shipments in July dropped 0.7%, which will weigh on September quarter GDP forecasts. Over the coming days, we’ll get several other pieces of economic July data including trade inventories and Personal Income & Spending reports. 

Coming off a better-than-expected July Retail Sales report, we expect investors will be closely watching the July Personal Income & Spending report to gauge the degree to which consumers can be counted on to power the economy in the second half of the year. In addition to the usual monthly economic data, this week will also bring us the second GDP estimate for the June quarter. As focused as some might be on that revision, we here at Tematica far more focused on what the continued slowdown in the current quarter means for the market and investors. 

Weekly Issue: While far from booming, U.S. economy not as bad as the headlines

Weekly Issue: While far from booming, U.S. economy not as bad as the headlines

Key points inside this issue

  • Thematic confirmation in the July Retail Sales report
  • Getting back to the global economy and that yield curve inversion
  • The week ahead
  • The Thematic Leaders and Select List
  • A painful reminder about dividend cuts

Despite Friday’s rebound, the stock market finished down week over week as it continued to grapple with the one-two punches of the slowing global economy and U.S.- China trade. There was much chatter on the recent yield-curve inversion, but as we look back at the economic data released last week, the U.S. economy continues to be on more solid footing than the Eurozone or China.

That’s not to say the domestic economy is booming. The Cass Freight Index, weekly railcar-traffic and truck-tonnage data and the July U.S. industrial-production report’s manufacturing component leave little question that America’s manufacturing economy is slowing. And as we saw last week, the U.S. consumer buoyed the economy in July with stronger-than-expected retail sales.


Thematic confirmation in the July Retail Sales report 

Last week’s July Retail Sales Report confirmed one of the key aspects of our Digital Lifestyle investment theme – the accelerating shift toward digital shopping that continues to vex brick and mortar retailers, particularly department stores. Granted, the year over year increase in non- store retail sales of 16.0%, which was several magnitudes greater than overall July Retail Sales that rose 3.4% year over year and bested sequential expectations, was aided by Thematic King Amazon’s (AMZN) 2019 Prime Day event but one month does not make a quarter. For the three months ending July, non-store retail sales rose 14.2% year over year, easily outstripping the 3.2% year over year comparison for overall retail sales. 

Clearly, the shift to digital shopping is not only underfoot, or more properly stated on a variety of keyboards, it is accelerating, and the victims continue to be department stores, electronics and appliance stores, sporting goods and bookstores, and to a lesser extent clothing and furniture. We’re seeing this play out in the results from Macy’s (M) as well as J.C. Penney (JCP), which is so strategically lost it is venturing into the used clothing market through a partnership with online consignment company thredUP. With its July quarter sales down 9% year over year, J.C. Penney is going for the “Hail Mary” pass with this move, but it’s only going to bring cheaper product in to compete with its already low-priced offering. I can almost understand the J.C. Penney is looking to double-down on our Middle-Class Squeeze investing theme, but it’s facing stiff competition from companies like Poshmark that are doing that as well as riding our Digital Lifestyle theme. 

Each of those challenged categories I mentioned above are also areas that Amazon continues to target with offerings from both third-party sellers as well as its growing private label line of products. I’ve often said Amazon shares are ones to hold, not trade, and we continue to feel that way as we approach the seasonally strongest time of the year for its business.


Getting back to the global economy and that yield curve inversion

For now, the U.S. economy remains the best house on the economic block — but it’s showing signs of wear. Of course, the fact the yield curve inverted briefly last week rang the “Recession Warning Bell.” But let’s remember that there’s historically been a lag of up to almost two years following that warning. Moreover, the Federal Reserve has already adopted a more dovish tone and will likely stand ready to add more stimulus to the economy if need be. All eyes will now on the Fed’s mid-September monetary-policy meeting.

Meanwhile, as economic-growth worries increased in the Eurozone and China last week, we heard about a big bazooka of stimulative measures that the European Central Bank is considering for its Sept. 12 policy meeting. China will also reportedly soon roll out a plan to boost disposable income over the coming quarters to spur its domestic consumption.

I would suggest you tune in later this week for what Tematica’s Chief Macro Strategist Lenore Hawkins has to say on this.

We’ll continue to monitor how global central bankers try to steer their respective economies in the coming weeks. While we suspect that Wall Street will likely cheer any and all dovish moves, the question remains how stimulative those policies will really be if the U.S.-China trade war continues.

U.S.-Chinese trade talks are set to resume in September, which tells us that we might get a lull in Wall Street’s recent volatility. But we should by no means think that “Elvis has left the building,” and we could very well see another round of turbulence in the coming weeks.


The Week Ahead

With two weeks to go until the Labor Day holiday weekend, we’re officially in the dog days of summer. These weeks historically see lower-than-usual trading volume, as investors and traders look to squeeze in that last bit of fun in the sun. Following last week’s full plate of economic data, this week will have a far smaller helping coming at us. Upcoming reports include July new- and existing-home sales, as well as the Index of Leading Economic Indicators.

Investors will also focus on what the latest flash PMI data from IHS Markit has to say about the global economy when that report lands on Aug. 22. I’ll be looking to see whether the U.S. economy continues to outperform Japan, China and the Eurozone following data out last week that suggested the German and Chinese economies continue to slow.

Reading those reports and the upcoming Federal Open Market Committee meeting minutes should set the stage for what we’re likely to hear when the FOMC next meets on Sept. 18. We’ll also have more data coming our way over the weeks leading up to the FOMC session, and we’re apt to get a few surprises along the way. While there’s no Fed interest-rate meeting scheduled for August, the Kansas City Fed will hold its widely watched annual Jackson Hole symposium Aug. 22-24 in Wyoming. The central bank doesn’t usually discuss monetary-policy plans at this event, but we aren’t exactly in normal times these days.

On the earnings calendar this week, the focus will continue to be on retail. If we were reminded of one thing last week in retail land, it’s that not all companies are responding the same way to retailing’s changing landscape. Just look at what we heard last week from Walmart (WMT), Macy’s (M) and JCPenney (JCP). Other key retail reports to watch this week include Home Depot (HD), Kohl’s (KSS), Lowe’s (LOW), Target (TGT), Dick’s Sporting Goods (DKS), and Foot Locker (FL). I’ll be looking for the degree to which they’re embracing digital shopping, as well as what they have to say about tariff implications and their expectations for 2019’s remainder.

We’ll also hear from Salesforce (CRM) and Toll Brothers (TOL), which should shed some light on the housing market and IT spending associated with our Disruptive Innovators and Digital Infrastructure investing themes.


The Thematic Leaders and Select List

As I noted above, last week was another choppy one for the stock market and those swings stopped out of Thematic Digital Infrastructure Leader Dycom Industries (DY) as well as Cleaner Living company International Flavors & Fragrances (IFF) shares. Given that we were stopped out, it means we took some losses in those two positions, but as I look at the live ones across the Thematic Leaders and the Select List I see an impressive array of returns with our Amazon, Costco Wholesale (COST), Chipotle Mexican Grill (CMG), McCormick & Co. (MKC), Walt Disney (DIS), Universal Display (OLED) and USA Technologies (USAT) shares. 

Wide swings in the market can present both challenging times as well as opportunities provided, we get some degree of clarity. As I touched on above, the first few weeks of September could be when we see that clarity emerge. Until then, we’ll continue to look for thematically well positioned companies at favorable risk to reward entry points. 


A painful reminder about dividend cuts

Last week I mentioned that the following – I’m focusing more on domestic-focused, inelastic business models that tend to spit off cash and drive dividends. In particular, I’m looking at companies with a track record of increasing their dividends every year for at least 10 years. And of course, they have to have vibrant thematic tailwinds at their respective back.

While I was doing just that, shares of famous lawn-mower engine maker Briggs & Stratton Corp. (BGG) — whose shares tumbled 44.5% last Thursday — presented a sharp reminder as to what can happen when a company cuts its dividend. Yes, the shares rebounded late last week along with the market, but they’ve been generally falling for a long time as the company’s dividend looked shakier and shakier.

Investors tend to think of quarterly dividends as payments in perpetuity, but these payouts are actually only declared at a company board’s discretion. When dividends are disrupted, that can lead to significant share-price pain for a stock.

In this case, Briggs & Stratton not only cut its dividend and reported a far-greater-than-expected quarterly loss, but also slashed its outlook for the balance of the year. The company now expects to earn just $0.20-$0.40 per share for the full year, which down significantly from its prior forecast of $1.30.

When matched up against its revised revenue forecast of $1.91 billion to $1.97 billion vs. a prior $2.01 billion, it’s rather evident that BGG’s cost structure has become an issue. So, it’s no little surprise that Briggs & Stratton also announced plans to close a plant that manufactures engines for the walk-behind lawn mowers you commonly find at Home Depot (HD) or Lowe’s (LOW) .

The company called out that product category in particular for weakness, which management attributed to the U.S. housing market’s current tone. I’ve previously talked about how new- and existing-home sales have been rather sluggish despite the recent mortgage-rate drop, with low rates fueling a wave of home refinancings rather than purchases.

But the biggest factor behind Thursday’s steep BGG dive was the fact that management slashed the company’s quarterly dividend by 64% to $0.05 per share from the prior $0.14. That one-two-three punch combination — bad earnings, a bad forecast and a dividend cut — sent Briggs & Stratton’s share price tumbling.

Going into Thursday morning’s earnings report, BGG shares were sporting a 6.8% dividend yield, which is on the lofty side. Investors should have interpreted that as a warning and here’s why – even before Thursday’s selloff, BGG shares had been down some 70% since January 2018, partly because the company missed analysts’ earnings expectations for the prior three quarters. In hindsight, the misses were escalating in percentage terms — a trend that continued with Thursday’s earnings report.

Paired with the dividend cut, there’s little confidence any more in the current management team, which means BGG shares are likely to flounder further due to several unknowns. Some of those unknowns are company specific, like: “Will be the plant closure deliver sufficient savings?” But others are about the U.S. economy’s future vector and velocity, which Thursday’s July industrial-production report shows is continuing to cool.

And while the July U.S. retail-sales report came in better than expected, we already know that consumers aren’t buying lawnmowers. And unfortunately, that’s not likely to change any time soon as we put the summer behind us.

The bottom line — as I’ve discussed before, when a stock’s dividend yield looks too good to be true, odds are it is just that. BGG is just the latest stock to prove that. While its newly revised dividend yield (4.1%) might still look enticing, it’s not one that we should be clamoring for given the lack of thematic tailwinds for its lawnmowing business. But at a minimum, no investor should consider the shares until there is some proof that management’s turnaround plan is on the cusp of delivering. 

Keys to July Retail Sales and Walmart Earnings Results

Keys to July Retail Sales and Walmart Earnings Results


Plus the Biggest Threat to the German Auto Industry

On this episode of the Thematic Signals podcast, we’re digging into the July Retail Sales and quarterly earnings results from Walmart as both confirm the hard-blowing tailwinds associated with our Digital Lifestyle, Middle-Class Squeeze, Aging of the Population and Cleaner Living Investing themes.





We also breakdown a recent article in The Wall Street Journalthat discusses how one aspect of our Cleaner Living investing theme — electric vehicles — could threaten the German economy. It’s the same structural shift that should have folks more than a little concerned about Tesla, both its business as well as its shares. All that and much more on this episode of the podcast. 

Have a topic or a conversation you think we should tackle on the podcast, email me at cversace@tematicaresearch.com

And don’t forget to subscribe to the Thematic Signals Podcast on iTunes!

Resources for this podcast:

Thematic Reading: Week of August 12, 2019

Thematic Reading: Week of August 12, 2019

Each week Team Tematica consumes a voracious amount of content as we look to stay on top of the latest data and mine it for tailwind and headwind signals for our 10 investment themes. For those that are less familiar with our investment themes, we’d suggest you visit or in some cases revisit this before proceeding further.

Below we’ve cobbled together a subset of the articles that caught our thematic eye over the last several days. As you can see this list not only touch on several aspects of our investment themes but the sources of these articles are rather diverse as well. In our view, this confirms not only the pervasive nature of our investment themes but the degree to which they are recognizable in the world around us, provided that one is seeing, listening and thinking thematically.

Weekly Issue: Trade and geopolitical issues make for a less than sleepy August 2019

Weekly Issue: Trade and geopolitical issues make for a less than sleepy August 2019

Key points inside this issue

  • Trade and geopolitical issues make for a less than sleepy August 2019
  • What to watch this week
  • Earnings this week
  • Economic data this week
  • The Thematic Aristocrats?

Uncertainty continued to grip the stock market last week as the U.S.-Chinese trade dispute once again took center stage. After the return of tariff talk week prior, the battle expanded this week to include a war of words between Washington and Beijing over the Chinese yuan’s devaluation.

The market ultimately shook that off, in part due to the renewed thought that the Federal Reserve could accelerate interest-rate cuts. But then stocks closed lower week over week after President Trump suggested Friday that trade talks with China set for next week might be canceled.

There’s also renewed geopolitical uncertainty — not just Britain’s Brexit process, but also a looming no-confidence vote against Italian Prime Minister Giuseppe Conte that’s once again plunging Italy into political turmoil. And as if that wasn’t enough, over the weekend escalating tensions between Chinese authorities and protesters in Hong Kong were added to the mix, making for one big ball of uncertainty even bigger.

Meanwhile, global economic data continue to soften. This gives some credence to the notion that the Fed could become more dovish than Chairman Jerome Powell suggested during his July 31 press conference following the Federal Open Market Committee’s decision to cut rates. While I don’t expect anything near-term, down below we have a calendar date to mark even though I don’t think it will mean much in the way of monetary policy.

We’re seeing confirming signs for the economic data in oil and copper prices, both of which have been mostly declining of late. Not exactly signs of a vibrant and growing global economy.

Odds are that as we head into summer’s final weeks, stocks will be range-bound at best as they trade based on the latest geopolitical headlines. And odds are there won’t’ be any newfound hope to be had on the earnings front. With 90% of S&P 500 stocks already reporting second-quarter results, it looks like we’ll see another year-over-year decline in quarterly average earnings. For the full year 2019 those earnings are only growing at a 2.5% annual rate, but if President Trump goes forth with the latest round of announced tariffs, odds are those expectations could come down in the coming weeks – more on that below.

All in all, barring any meaningful progress on US-China trade, which seems rather unlikely in the near-term, at best the stock market is likely to be rangebound in the coming weeks. Even though much of Wall Street will be “at the beach” the next few weeks, odds are few will be enjoying their time away given the pins and needles discussed above and further below.

What to watch this week

We have three weeks until the Labor Day holiday weekend, which means we’re entering one of the market’s historically slowest times. There’s typically lower volume than usual, as well as low conviction and wishy-washy moves in the market.

Traditionally, a more-sobering look emerges once Wall Street is “back from the beach” following the Labor Day holiday. This tends to bring a sharper picture of the economy. There are also ample investor conferences where companies update their outlooks as we head into the year’s last few months.

But as we saw this past week, geopolitical and trade tensions could make the next few weeks much more volatile than we’ve seen in the past. As we navigate these waters, we’ll continue to assess what this means for earnings — particularly given that analysts don’t expect the S&P 500 companies to see year-over-year earnings-per- share growth again until the fourth quarter. In my view that puts a lot of hope on a seasonally strong quarter that could very well be dashed by President Trump’s potential next round of tariffs. I say this because retailers now face the 10% tariffs set to go into effect on September 1, which will hit apparel and footwear, among other consumer goods.

The risk is we could very well see 2019 turn into a year with little to no EPS growth for the S&P 500, and if factor out the impact of buybacks it likely means operating profit growth had at the S&P 500 is contracting year over year. We’ll know more on that in the coming weeks, but if it turns out to be the case I suspect it will lead many an investor to question the current market multiple of 17.6x let alone those market forecasters, like the ones at Goldman Sachs, that are calling for 3,100 even as their economists cut their GDP expectations.

Earnings this week

This week will have the slowest pace of earnings releases in about a month, with only some 330 companies issuing quarterly results. That’s a sharp drop from roughly 1,200 such reports that we got last week.

Among those firms reporting numbers next week, we’ll see a sector shift toward retail stocks, including Macy’s (M), J.C. Penney (JCP) and Walmart (WMT). Given what I touched on above, I’ll be listening for their comments on the potential tariff impact as well as comments surrounding our Digital Lifestyle and Middle-class Squeeze investing themes, and initial holiday shopping expectations.

This week’s earnings reports also bring the latest from Cisco Systems (CSCO), Nvidia (NVDA), and Deere (DE). Given how much of Deere’s customer base sells commodities like U.S. soybeans (which China has hit with tariffs), we’ll carefully listen to management’s comments on the trade war. There could be some tidbits for our New Global Middle-class theme from Deere as well. With Cisco, we could hear about the demand impact being generated by 5G network buildouts as well as the incremental cyber security needs that will be needed. These make the Cisco earnings conference call one to listen to for our Digital Infrastructure and Safety & Security investing themes.

 

Economic data this week

On the economic front, we’ll get July reports for retail sales, industrial production and housing starts, as well as the August Empire Manufacturing and Philly Fed surveys. Given the importance of the consumer, the July Retail Sales will be one to watch and I for one expect it to be very bullish for our Digital Lifestyle investing theme if and only if because of Amazon’ 2019 Prime Day and all the other retailers that tried to cash in on it. I suspect, however, the report will reveal more gloom for department stores. All in all the week’s economic data points will help solidify the current quarter’s gross domestic product expectations, which are sitting at 1.6%-1.9% between the New York and Atlanta Fed.

Based on what we’ve seen of late from IHS Markit for Japan, China and the Eurozone, that still makes America the best economic house on the block. Granted, the U.S. vector and velocity are still in the down and slowing positions, but we have yet to see formal signs of a contracting domestic economy. As Tematica’s Chief Macro Strategist Lenore Hawkins pointed out in her most recent assessment of things, we’ll need to keep tabs on the dollar for “The deflationary power of a strengthening US dollar strength in the midst of slowing global trade and trade wars just may overpower anything central banks try.”

Odds are that as the latest economic figures hit, especially if they keep the economy’s recent vector and velocity intact, we will see more speculation on what the Fed might do next. While there’s no Fed interest-rate meeting scheduled for August, the Kansas City Fed will hold its widely watched annual Jackson Hole symposium Aug. 22-24 in Wyoming. The central bank doesn’t usually discuss monetary-policy plans at this event, but as noted above, we aren’t exactly in normal times these days.

 

The Thematic Aristocrats?

Given the recent market turbulence as prospects for more of the same in the coming weeks, I’m sitting back and building our shopping list for thematically well-positioned companies. Given the economic data of late and geo-political uncertainties as well as Lenore’s comments on the dollar, I’m focusing more on domestic-focused, inelastic business models that tend to spit off cash and drive dividends. In particular, I’m looking at companies with a track record of increasing their dividends every year for at least 10 years. And of course, they have to have vibrant thematic tailwinds at their respective back.

Perhaps, we can informally call these the “Thematic Aristocrats”?

I’ll have more as I refine that list.